Practical Law

The exemption from the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (LASPO) for insolvency litigation will come to an end on 1 April 2016. Despite some strong lobbying by business groups, led by R3, CFA success fees and ATE insurance premiums will no longer be recoverable from the defendant if a successful claim is brought.

The arguments for and against the insolvency exemption will (by now) be well known to you. In a nutshell, Jackson LJ is of the view that CFAs were not brought in to benefit insolvency practitioners (IPs), and that recoverability of success fees and ATE insurance premiums are oppressive and drive up the overall cost of litigation. The insolvency profession is of the view that the end of the insolvency exemption will leave rogue directors unaccountable when they have committed a fraud, acted negligently or wrongly withdrawn money from a business. This will ultimately be to the creditors’ detriment, including the taxpayer.

This post is a whistle-stop tour of the likely consequences for IPs, insolvency lawyers, potential defendants and creditors.

IPs and insolvency lawyers

Before IPs and insolvency lawyers enter into a CFA, a matter is generally subject to much consideration and scrutiny. It usually follows many months of analysing the information available, liaising with the potential defendant to hash out the issues and exploring settlement options. The decision is never taken lightly.

Success fees were used as a way to compensate lawyers taking on these risky cases on a no win, no fee basis. The end of the insolvency exemption will not ban success fees, but they will no longer be recoverable from the defendant. In the circumstances, lawyers will either:

• Recover the success fee from the damages awarded through DBAs: This will mean less of the recovery will be paid to the creditors and, depending on the level of damages awarded to the insolvent estate, may even result in conflict between the IPs and the lawyers (if the damages awarded do not allow the lawyers to recover the full success fee, and the IPs the costs of their appointment, while also leaving a sizeable sum to pay the creditors).
• Progress the matter without the uplift: This will inevitably reduce the number of solicitors and barristers prepared to take on this work, even if the claim is considered to have strong merits.
• Not progress the matter beyond the pre-action stage: If this is the preferred approach, it will not take potential defendants long to work out that many IPs and their legal advisers will not be prepared to pursue a matter beyond the pre-action stage. This may result in more rogue directors keeping their ill-gotten gains at the expense of creditors.

IPs will have the option of selling the litigation to a third party funder, who will have no prior connection to the litigation but will agree to finance all or part of the legal costs in return for a fee payable from the proceeds recovered. However, despite this option, the majority of IPs are of the view that the end of the exemption will stifle proper claims that should be brought.

Creditors

A 2014 report by the University of Wolverhampton, commissioned by R3, found that IPs return £160m to creditors from rogue directors every year, so the current regime appears to be working well. Some IPs are of the view that creditors will have to become more engaged in the litigation process. Of course, creditors could fund the claims themselves, but this seems very unlikely given that many will view this as throwing good money after bad. Creditors’ committees may see a resurgence, acting as a touch-stone for an IP in handling the litigation.

However, the overwhelming view of IPs is that the end of the insolvency exemption will mean lesser funds are recovered for creditors.

Defendants (former directors)

Jackson LJ has referred to the recoverability regime as an “instrument of oppression.” It has been argued that defendants, who have good prospects of defending a claim, settle it due to the “blackmail” effect of the recoverability regime.

However, Philip Sykes, President of R3, is of the view that the exemption helps level the playing field between creditors and those withholding money from them. With no exemption, rogue directors and others actually have an incentive to withhold creditors’ money from insolvent estates, as it makes it almost impossible to fund legal action against them.

Conclusion

It goes without saying that the recoverability of success fees and ATE insurance premiums are a factor in a defendant’s decision whether to continue to defend the litigation being brought against them, or to settle. The removal of the insolvency exemption will allow defendants to make the point that continuing to run a case will eat into recoveries and make the cost/benefit analysis of the claim unjustifiable. It is no doubt true then that these reforms will make life tougher for creditors and the insolvency profession going forward, and that the sums recovered for insolvent estates will suffer as a result.

The government has announced that there will be a post-implementation review of the reforms in part 2 of LASPO prior to April 2018. Hopefully this allows enough time for the insolvency profession to gather sufficient data to understand the impact of these reforms and, if appropriate, challenge the government to reconsider the insolvency exemption.